November 28, 2023

Drilling down into corporate governance


By James Sterling, Head of Claims (with commentary from Underwriter Craig Watson)

Drilling down into corporate governance

For current UK company board directors, managing corporate governance is already demanding. With further regulatory changes expected from January 2025, this blog offers Kayzen’s brokers and clients an early heads-up as to what may be coming, and our D&O underwriting perspective on what characteristics we will be reviewing. 

What is Corporate Governance

The  UK Corporate Governance Code 2018, overseen by the Financial Reporting Council (FRC)  as part of UK company law, enshrines good board practice and infrastructure requirements. Compliance is obligatory for ‘premium’ publicly listed companies (PLCs), while ‘standard’ public and private companies are also encouraged to comply1. The Code follows a principles-based approach, requiring companies to “comply or explain” when submitting their annual accounts. 

The Code primarily addresses relationships between companies, shareholders and other stakeholders, with a view to long-term sustainable growth of the UK economy and reflecting recent reviews on proportionate remuneration and diversity. 

Since July 2018, various factors have impacted UK supply chain and inflation, most directly Brexit, COVID, and the Russia/Ukraine war. Globally, movements like the “#MeToo” & “Black Lives Matter”, shifts in US leadership, the ongoing climate change crisis and international tensions have shaped the world stage.

Against this challenging backdrop, UK directors must not only “promote the success of the company”2 , which no longer just entails financial success, but also consider broader factors and stakeholders, particularly environmental and community impact.

Pending changes

No changes have been finalised yet, but earlier in 2023, the FRC published a new draft Code. The consultation phase ended in September 2023 and it’s evident that key government, regulatory, finance and environmental stakeholders support this new Code. Consequently, we anticipate significant changes, likely applicable to accounting years commencing on or after 1 January 2025.

Expect the current principles to be modernised and a new principle encouraging an outcomes-based approach, where companies must demonstrate meeting their stakeholder needs (something which the FRC reports is currently lacking).

The FCA would like to eliminate the distinction between premium and standard listed companies, making the Code applicable to all PLCs. This would be combined with plans to water down the UK listing requirements, with the UK Treasury keen to encourage more companies to list in the UK rather than the current trend of opting for an “easier” US listing. However, there has already been push back from UK institutional investors seeking to protect the integrity of the UK stock market. This item, therefore, remains up for discussion within the context of other pending changes which arguably make a UK listing more onerous in any event.

The government is closely examining the audit space following the publication of a White Paper Restoring Trust in Audit and Corporate Governance, advocating for stronger controls in annual reporting, a new minimum standard for external audit, developing an audit and assurance policy, an enhanced resilience statement and competitive auditing tender processes. We had also expected the FRC to be reconstructed as the Audit, Reporting and Governance Authority (ARGA), albeit some industry experts think the passage of time means this is becoming increasingly unlikely.

Risk Management is also on the radar, with D&Os personally accountable for identifying and managing internal controls and emerging risks, including via board-performance reviews. Watch out for:

  • The Economic Crime (Transparency and Enforcement) Act (June 2022) sanctions enforcement, particularly regarding Russia/Ukraine.
  • The Economic Crime & Corporate Transparency Act (October 2023) introducing a new “failure to prevent” fraud offence that may lead to criminal liability for D&Os.

Unsurprisingly, ESG is a focal point for the anticipated modernisation, as the scope of s172 of the Companies Act gets ever broader and stricter EU, US and global rules are pending in 2024. Expect more structured and stringent ESG reporting aligned with company culture and strategy. The main challenge here will be striking the right public balance when setting genuine and feasible ESG targets, so as to avoid accusations of green-hushing or green-washing3.

Effective equal opportunity policies, including diverse appointments and inclusive succession planning, will continue to be scrutinised, with the Worker Protection (Amendment of Equality Act 2010) Bill expected to become law early in 2024. This follows the McDonald’s litigation imposing a proactive duty on employers to take reasonable steps to prevent sexual harassment of their employees.

Directors should also consider:

  • Balancing non-company board appointments impinging on company management responsibilities. The draft Code states that “full-time executive directors should not take on more than one non-executive directorship in a FTSE 100 company or other significant appointment.” Similarly, professional directors with multiple directorships in smaller entities will need to re-assess their commitments.  As Craig Watson observes, “There have to be questions raised over directors of multiple boards of unrelated companies. Can they really justify exercising their duty of reasonable care, skill and diligence if they have dozens of directorships?”. That logic extends to directors who sit on a multitude of offshore company boards, albeit note UK legislation does not typically apply here.
  • Updated guidance on directors’ remuneration, including what ‘proportionate’ pay means in relation to the company performance, long-term purpose and values, and claw-backs for serious management failings (again, not really the “light touch” the UK treasury is aspiring after to attract more UK listings). 

Kayzen’s perspective 

At Kayzen, we take an open-minded and balanced approach when assessing an insured’s risk profile, including corporate governance adherence. We recognise that a one-size-fits-all approach doesn’t apply, especially when evaluating our SME portfolio. As mentioned in our recent ESG blog, the contribution of Corporate Governance is extremely important. Poor corporate governance is an indicator of high risk, so there are certain fundamentals we will closely watch for, including the following:

  • A clearly articulated and up-to-date corporate strategy and suitable governance structure.
  • Evidence of implementation in a holistic way across functions and jurisdictions.
  • Cultural work done communicating the company’s purpose and methodology to staff, ensuring transparency around the ‘why’, ideally with evidence of employee buy-in at all levels (reluctance to change can be a blocker).
  • Specific risk management indicators such as:
    • Performance KPIs and other monitoring measures, together with evidence of follow-up and remediation where required.
    • Transparent and evolving insights into the company's ESG plans.
    • Steps taken to balance stakeholder demands with the need for solvency in the current economic climate. 
    • A credible data and cyber management policy, noting the recent increase in the SME space for poor data controls.
    • Maintaining an audit trail within board and sub-committee minutes for key decisions, essential for defending against litigation, such as new board claims against the old board for breach of fiduciary duty.
  • Information about a company's plans to implement the anticipated Code changes.

Over to Craig to round things off:

“The foregoing confirms the fact that decision-makers must have suitable personal insurance protection. A D&O contract should never refer to Acts or changes in corporate or regulatory governance. The Policy is designed to be fluid and, in effect, allow the board, their directors, and their management team to steer their strategy whilst managing any incoming regulatory or governance expectations. This merely forms part of the ‘business cycle’ and should not impact the D&O cover in place. Whilst our underwriters will maintain a keen eye on how any changes may impact an existing or prospective client, the cover itself should remain true to its primary obligation to provide the ‘Insured Persons’ with an indemnity should their decision-making be called into question.”

1. “Premium” UK PLCs comply with higher global listing standards to potentially be eligible to trade in the top 100 companies on the London Stock Exchange (the FTSE 100). “Standard” UK PLCs comply with less onerous European listing standards.
2. s172 of the Companies Act 2006
3. While “greenwashing” misleads consumers through false ESG claims, “greenhushing” intentionally downplays genuine sustainability efforts.  

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